The Value of Stock
A stock's value can change at any moment, depending on market conditions, investor perceptions, or a host of other issues.
A stock's value can change at any moment, depending on market conditions, investor perceptions, or a host of other issues.
A stock doesn't have a fixed price, or value. When investors are buying the stock, the price tends to go up. But if they think the company's outlook is poor, or if the overall market is weak, they either don't invest or sell shares they already own. Then the price of the stock tends to fall.
But price isn't only one way to measure a stock's value. Return on investment — the amount you earn by owning the stock — is another. To assess return, you add any increase or decrease in price from the time of purchase and any dividends the stock has paid over that time. Then you divide by the amount you invested to find percent return. As a final step, you can find the annualized return by dividing the return by the number of years you owned the stock.
But price isn't only one way to measure a stock's value. Return on investment — the amount you earn by owning the stock — is another. To assess return, you add any increase or decrease in price from the time of purchase and any dividends the stock has paid over that time. Then you divide by the amount you invested to find percent return. As a final step, you can find the annualized return by dividing the return by the number of years you owned the stock.
THE BLUES AT BIGCO.
The peaks and valleys in the price of a stock dramatically illustrate how value changes.
CYCLICAL STOCKS
All stocks don't act alike. One difference is how closely a company's business is tied to the condition of the economy. Cyclical stocks are shares of companies that respond predictably to the economy's ups and downs. When things slow down, their earnings typically fall, and so does their stock price. But when the economy recovers, earnings rise and the stock price goes up. Airline and hotel stocks are typically cyclical: People tend to cut back on travel when the economy is slow. In contrast, stock prices for companies that provide necessary services and staples, such as food and utilities, tend to stay fairly stable.
INCOME STOCKS, GROWTH STOCKS |
The trick to making money, of course, is to buy a stock before others want it and sell before they decide to unload. Getting the timing right means you have to pay attention to:
- The rate at which the company's earnings are growing
- Competitiveness of its products or services
- The availability of new markets
- Management strengths and weaknesses
- The overall economic environment in which the company operates
Investing may be a bit of a gamble, but it's not like betting on horses. A long shot can always win the race even if everyone bets the favorite. In the stock market, the betting itself influences the outcome. If lots of investors bet on Atlas stock, Atlas's price will go up. The stock becomes more valuable because investors want it. The reverse is also true: If investors sell Zenon stock, it will fall in value. The more it falls, the more investors will sell.
MAKING MONEY WITH STOCKS You may make money with stocks by selling your shares for more than you paid for them or by collecting dividends on the stocks — or both.
The profit you make on the sale of stock is known as a capital gain. Of course, it doesn't all go into your pocket. You owe taxes on the gain as well as a commission on the sale, but if you've owned the stock for more than a year, it's a long-term gain. That means you pay the tax at a lower rate — sometimes substantially lower — than you pay on your earned income or on interest income.
Dividends are the portion of the company's profit paid out to its shareholders. A company's board of directors decides how large a dividend the company will pay, or whether it will pay one at all. Typically, large, mature companies pay dividends, while smaller ones tend to reinvest their profits to fund growth. From your perspective, one of the advantages of dividend income is that through 2010 qualified dividends are taxed at your long-term capital gains rate — 15% if your marginal tax rate is 25% or higher and 0% if it's 10% or 15%.
The profit you make on the sale of stock is known as a capital gain. Of course, it doesn't all go into your pocket. You owe taxes on the gain as well as a commission on the sale, but if you've owned the stock for more than a year, it's a long-term gain. That means you pay the tax at a lower rate — sometimes substantially lower — than you pay on your earned income or on interest income.
Dividends are the portion of the company's profit paid out to its shareholders. A company's board of directors decides how large a dividend the company will pay, or whether it will pay one at all. Typically, large, mature companies pay dividends, while smaller ones tend to reinvest their profits to fund growth. From your perspective, one of the advantages of dividend income is that through 2010 qualified dividends are taxed at your long-term capital gains rate — 15% if your marginal tax rate is 25% or higher and 0% if it's 10% or 15%.
Most dividends paid by US corporations are qualified, as are dividends paid by a number of international firms. So is most dividend income that mutual funds pass along to you. But dividends from real estate investment trusts (REITs) and mutual savings banks are not qualified. You should check the year-end 1099 statements you receive from financial institutions and discuss which income qualifies for the lower rate with your tax adviser.
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